Question

Net Present Value Method

The following data are accumulated by Reynolds Company in evaluating the purchase of $121,300 of equipment, having a four-year useful life:

	Net Income		Net Cash Flow
Year 1	$42,000		$72,000
Year 2	26,000		55,000
Year 3	13,000		42,000
Year 4	(1,000)		28,000

Present Value of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	0.890	0.826	0.797	0.756	0.694
3	0.840	0.751	0.712	0.658	0.579
4	0.792	0.683	0.636	0.572	0.482
5	0.747	0.621	0.567	0.497	0.402
6	0.705	0.564	0.507	0.432	0.335
7	0.665	0.513	0.452	0.376	0.279
8	0.627	0.467	0.404	0.327	0.233
9	0.592	0.424	0.361	0.284	0.194
10	0.558	0.386	0.322	0.247	0.162

a. Assuming that the desired rate of return is 15%, determine the net present value for the proposal. Use the table of the present value of $1 presented above. If required, round to the nearest dollar.

Present value of net cash flow	$
Less amount to be invested	$
Net present value	$

b. Would management be likely to look with favor on the proposal?

The net present value indicates that the return on the proposal is (choose one: greater, less) than the minimum desired rate of return of 15%.

Answer 1

a. Desired rate of return =15%

Calculation of present values of the cash inflows :

Yr1 - 72000*.870 = $62640

Yr2 - 55000*.756 = $41580

Yr 3- 42000*.658 = $27636

Yr 4 - 28000*.572 = $16016

Total = $147872

Amount invested = $121300

Net present value = $26572

b. Yes the management is likely to look with favor on the proposal since the NPV is positive , which means that the return on the proposal is higher than the minimum desired rate of 15%

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